Checks and balances for shale development are local

Andrew Thomas is Executive in Residence at the Energy Policy Center of the Levin College of Urban Affairs at Cleveland State University.

Last week we hosted in our offices at Cleveland State University a shale fact-finding contingent from Ukraine, which was investigating the development of shale in Ohio. My colleague in the Energy Policy Center at CSU, Iryna Lendel, had just returned from a lengthy shale research assignment in Ukraine, and had warned me to expect hostility from this group toward hydraulic fracturing. She was right.Even though our presentation was supposed to be about the economics of shale development, we kept coming back to the environmental risks, and there were plenty of animated discussions. The Ukrainians understand the fundamental issue: balancing environmental risk against economic value. They also understand that it is not enough to simply dismiss fracking as too dangerous without considering what the risks are for alternatives to meet our energy requirements. Studying Ohio makes sense in making this assessment: both regions are dependent upon cheap natural gas to fuel their economies. Both regions have had heretofore a small oil and gas industry, and are not able to immediately ramp up a large upstream service sector. And both regions are densely populated, making environmental problems more troubling.

Yet, despite these similarities, Ukrainians seem to have reached a different conclusion in balancing these issues. The shale industry there is struggling to take off, despite an economy that continues to be threatened by the whims of Russian oil and gas giant Gazprom. But in Ohio, it is off and running, with billions of dollars being invested in upstream and midstream oil and gas activities, notwithstanding some nagging environmental concerns.

Local benefits result in local support

So why doesn't shale development enjoy the same public support in Ukraine that it does in Ohio?There are rumors that Gazprom is fomenting distrust among the population with a well-funded anti-fracking campaign. But there is actually a simpler, less devious explanation for this ambivalence: there is no private ownership of mineral rights in the Ukraine. In Ohio, mineral rights are owned privately.It turns out that in the court of public opinion, for the balancing test to work in favor of development, the economic value derived has to have significant local impact. That is because the inconvenience and environmental risk borne are local.In Ohio, local support is generated first and foremost by landowners. The balancing test analysis is pretty straightforward for them: they receive generous lease bonus and royalty payments from the developers, and they can and do put into their leases more environmental protections than are provided by Ohio regulatory law. But this mineral ownership scenario is unique to the United States and Canada. In the rest of the world, the sovereign owns all oil and gas development rights, including those that lie below privately owned lands. This policy, on first blush, makes a great deal of sense. When we purchase land in the United States, we don't expect to acquire the airspace thousands of feet above us. Why should we own the minerals thousands of feet below us?

The problem with sovereign ownership, however, is that it does not work in places where a local balancing test is required. Simply, without a local ownership interest in the minerals, there is no incentive for the people who live in the development areas to support the development. They incur all the inconvenience, but get none of the value. This problem has caused some nations, such as Nigeria, to endure massive civil unrest in and around oil and gas production. To be sure, the locals do benefit under this system. Locals, after all, have a strong interest in a well-funded government with low taxes. But this benefit is so far removed from them that they can't see it. And try explaining to someone who has to watch a gas well flaring in his backyard why everyone else is entitled to the same benefit he receives from that well. In the Ukraine, this presents an especially difficult problem: the public has little trust in its government. As with other former Soviet nations, there is risk of public corruption and no sense among the locals who suffer the inconvenience that they will ever see any value whatsoever derived from the development. Post-Chernobyl Ukraine will need to see a clear economic value proposition before it buys into shale development.

Jobs are key

So what does this all mean for us here in Ohio? For one thing, it reaffirms the value of the American system for mineral development. Private ownership may seem unfair to those of us who are left out of the boom, but in fact this is the system that has enabled America to be the leader in oil and gas development for the past 100 years, despite steadily depleting reserves. The severance tax appears to be the best way to ensure the public receives some direct value from oil and gas development. But more importantly, it also brings into focus what the oil industry needs to do if it wants to continue to be on the winning end of the “balancing test”: employ locals, and lots of them.Landowners are the big local winners in the shale boom. They will continue to support the industry so long as there develops no pattern of environmental abuse. But they comprise a small minority of the folks directly affected by shale development.There remains a great deal of work to do to establish the benefit to local communities who share much of the inconvenience and environmental risk with the landowners, but not the royalty and bonus windfalls.

Morning Roundup

Business headlines from Crain's Cleveland Business and other Ohio newspapers — delivered FREE to your inbox every morning. Sign up for the Morning Newsletter.